Tax liability dilemma

[maverick18]

Hi All ..this query is for a friend who has registered but is awaiting confirmation on ContractorUK ..

His first Company year comes to a close on 31st May 2011 and his tax liability is £7k ..however he only has £2k in his business bank a/c right now due to short term withdrawal for medical reasons ..

what would be the implications if the books close on 31st May 2011 with only £2k in his Business Bank a/c?

He is expecting to pay off the total tax liability much before time (9 months after May 2011). Would this be an issue with HMRC??

Many thanks.

[NotAllThere]

What was the nature of the withdrawal? Dividend payment, director's loan?

[Robot]

What was the nature of the withdrawal? Dividend payment, director's loan?

It would be a directors loan; as the company didn't have enough reserves to pay it as a legal dividend and therefore illegal and should be treated as a directors loan.

Potential problems

Section 419, tax but as your friend will pay the tax within nine months and a day, there is not problem there.

BIK on the loan account, if over £5k, this will have to reported on the P11d, up to the point the loan went below £5k.

Robot

[Wanderer]

The accountants can confirm but here's my understanding:

The money taken will have to be treated as a director's loan because there were not profits to pay dividends.

If the loan is < £5000 then it can just be paid back with no benefit in kind. If it's a penny over than then the director has to either have the loan treated as a beneficial loan which attracts BIK tax or pay 4% interest (check with HMRC for the current rate) to the company, the interest becomes company income and can be paid back to the director (minus tax).

It's vital that the loan is paid back before 9 months after the end of the company's tax year. If this is not done then there is a tax charge of 25% of the loan value. This can be reclaimed but only in the tax year after the loan is repaid so kiss good bye to that 25% for a while.

Bottom line, you can take the loan but you absolutely must avoid having director's loans outstanding more than 9 months after the end of the tax year.

[Clare@InTouch]

The accountants can confirm but here's my understanding:

The money taken will have to be treated as a director's loan because there were not profits to pay dividends.

If the loan is < £5000 then it can just be paid back with no benefit in kind. If it's a penny over than then the director has to either have the loan treated as a beneficial loan which attracts BIK tax or pay 4% interest (check with HMRC for the current rate) to the company, the interest becomes company income and can be paid back to the director (minus tax).

It's vital that the loan is paid back before 9 months after the end of the company's tax year. If this is not done then there is a tax charge of 25% of the loan value. This can be reclaimed but only in the tax year after the loan is repaid so kiss good bye to that 25% for a while.

Bottom line, you can take the loan but you absolutely must avoid having director's loans outstanding more than 9 months after the end of the tax year.

Agreed.

The extra tax due is the s419 (now s455) that Robot mentioned above.

[Bradley]

No need to pay

It's vital that the loan is paid back before 9 months after the end of the company's tax year. If this is not done then there is a tax charge of 25% of the loan value. This can be reclaimed but only in the tax year after the loan is repaid so kiss good bye to that 25% for a while.

Bottom line, you can take the loan but you absolutely must avoid having director's loans outstanding more than 9 months after the end of the tax year.

As a warning I would say that if the period to 31st May 2011 is longer than 12 months it could be that the s455 tax is due earlier as it is 9 months after the end of the company's accounting period for tax purposes that matters e.g. 17 months to 31st May 2011 = 2 tax accounting periods one ending 31st December 2010 the other 31st May 2011 => s455 payment dates are 1st October 2011 and 1st March 2012.

If your friend will have the £7k to pay the balance back then presumably he/she would have earned enough profit to declare a dividend to clear the loan account balance. If the company is liquidated then the loan balance would be effectively written-off so ineither event a cheque won't need to be written back to the company.

[Robot]

As a warning I would say that if the period to 31st May 2011 is longer than 12 months it could be that the s455 tax is due earlier as it is 9 months after the end of the company's accounting period for tax purposes that matters e.g. 17 months to 31st May 2011 = 2 tax accounting periods one ending 31st December 2010 the other 31st May 2011 => s455 payment dates are 1st October 2011 and 1st March 2012.

If your friend will have the £7k to pay the balance back then presumably he/she would have earned enough profit to declare a dividend to clear the loan account balance. If the company is liquidated then the loan balance would be effectively written-off so ineither event a cheque won't need to be written back to the company.

Surely if the company was liquidated by a liquidator, the liquidator would have every right to chase the debtors of the company, which in this case would be the director, due to the fact he/she had an overdrawn loan account, so the director would have to pay the £7k or £5k, back to the company?

[maverick18]

Thank you guys ..appreciate all your responses.

A final query though .. dividends can be paid out of 'after tax' profits.

When I look at my friend's business bank a/c statements, there are a couple of months where the cash balance in the statement goes to almost zero due to 'dividends' withdrawn in the previous transaction. Subsequently, there are invoices paid and the cash balance is restored to around the expected Corporate Tax liability.

Are these dividends valid or these also have to be classified as Director's Loan?

My guess is that HMRC takes a view at the end of the year as to whether there were enough profits earned for a certain level of dividends to be declared and would not go into the daily transactions of a ltd company. Is that correct?

[ASB]

Thank you guys ..appreciate all your responses.

A final query though .. dividends can be paid out of 'after tax' profits.

When I look at my friend's business bank a/c statements, there are a couple of months where the cash balance in the statement goes to almost zero due to 'dividends' withdrawn in the previous transaction. Subsequently, there are invoices paid and the cash balance is restored to around the expected Corporate Tax liability.

Are these dividends valid or these also have to be classified as Director's Loan?

My guess is that HMRC takes a view at the end of the year as to whether there were enough profits earned for a certain level of dividends to be declared and would not go into the daily transactions of a ltd company. Is that correct?

The dividends are only valid if:-

1/ They were appropriately declared and minuted at the time they were made (strangely paperwork often gets temporarily mislaid)
2/ There is the retained earnings to pay them

This is not necessarily dependant on the cash position.

Consider a May year end and:-

a/ Only invoice in the year was 10k issued in may
b/ As at 31/5 this issue remains unpaid
c/ There were no expenses
d/ The bank balance is zero (invoice unpaid as at 31/5)

In this case there is profit of 10k, retained funds go up by 10k and it would be possible to vote and pay a dividend of 10k (assuming zero tax liability which is unlikely to be the case). How the dividend is actually financed is a different thing.

Of course this assumes that the debt is not doubtful. A similar issue arises with work in progress. This has a value and contributes to profit. This arises because the books are done with accrual based accounting, not cash based accounting.

Whether or not this covers your friend or not I wouldn't have a clue of course. They could also think about extending their accounting year - though I suspect it is now too late for that if the y/e date is today.

[maverick18]

The dividends are only valid if:-

1/ They were appropriately declared and minuted at the time they were made (strangely paperwork often gets temporarily mislaid)
2/ There is the retained earnings to pay them

This is not necessarily dependant on the cash position.

Consider a May year end and:-

a/ Only invoice in the year was 10k issued in may
b/ As at 31/5 this issue remains unpaid
c/ There were no expenses
d/ The bank balance is zero (invoice unpaid as at 31/5)

In this case there is profit of 10k, retained funds go up by 10k and it would be possible to vote and pay a dividend of 10k (assuming zero tax liability which is unlikely to be the case). How the dividend is actually financed is a different thing.

Of course this assumes that the debt is not doubtful. A similar issue arises with work in progress. This has a value and contributes to profit. This arises because the books are done with accrual based accounting, not cash based accounting.

Whether or not this covers your friend or not I wouldn't have a clue of course. They could also think about extending their accounting year - though I suspect it is now too late for that if the y/e date is today.

Thanks a ton mate. That clears it up